Long overdue energy subsidy reform remains a key concern for Egypt’s newly appointed interim government. It is an issue which will need to be addressed soon given tight supply and rising demand and the government’s inability to finance purchases of petroleum products. The frequent fuel shortages and power outages that have beset Egypt, point to a country struggling to sustain a system of untargeted subsidies that are an economic burden but, at the same time, are too politically sensitive to restructure.
In the past two-and-half years Egypt’s economy has been hit by successive economic crises beginning with a sharp decline in foreign international reserves followed by high inflation and a ballooning budget deficit estimated at almost 11.5 percent of GDP. Fuel subsidies remain a major constraint on finances accounting for about one-third of public spending and one-fifth of state expenditures. In fiscal year 2012-2013 (ending June 30) fuel subsidies alone are projected to reach EGP 120 billion ($17.5 billion), accounting for 6 percent of GDP.
Egypt’s energy crisis has been exacerbated by rising demand in the face of declining gas production and the inability of the government to pay for fuel, both imported and domestically produced by international companies. State-owned Egyptian General Petroleum Company remains the most indebted body in the Egyptian government with billions of dollars in outstanding debt. This stifled investment in new projects and led to the deterioration of refineries resulting in less employment opportunities in the oil and gas sectors.
As a temporary solution, Egypt accepted Arab aid to mitigate energy shortages. Recent multi-billion dollar emergency financing pledged by Kuwait, Saudi Arabia, and United Arab Emirates (UAE) includes over $3 billion in energy grants. In the past, Egypt relied on loans and grants from Qatar to purchase diesel and gasoline, while turning to Libya and Iraq for crude oil. Egypt is looking to sign a flexible credit agreement with Iraq, but delivery has yet to begin as Iraq, as well as Libya, have been cautious about the possibility of payment defaults since oil will be purchased on credit and Egypt has been unable to provide credible bank guarantees. Since former president Mohamed Morsi’s ouster, Egypt received $200 million in petroleum products from Kuwait, $3 billion from UAE and $2 billion deposit in Central Bank of Egypt from Saudi Arabia.
In the past year, in an attempt to ease Egypt’s energy crisis, Morsi’s government undertook a set of measures to tackle subsidies, only to rescind some decisions due to popular pushback. On the other hand, the decisions that did go though resulted in unintended consequences. For example, last December the government increased the price of 95-octane gasoline used by luxury automobiles, pushing motorists to consume more subsidized 92-octane gasoline. The move instead resulted in long lines at the pumps. Similarly, by restricting distribution of heavily subsidized low-grade gas to certain military-operated stations, gas queues at the pumps fueled public unrest. In April the price of cooking gas cylinders increased to EGP 8 ($1.15) for households and EGP 16 for businesses ($2.30), up from EGP 5 ($0.73) but the move did not yield the high profits expected by the government because it is used by a relatively small percentage of the population.
Previously, the government announced plans to cut subsidies for energy-intensive industries and establish a coupon system for butane gas distribution. Last month, Mahmoud Nazim, former secretary of the Petroleum Ministry, announced the government’s plan to introduce a system of smart cards to distribute fuel by rationalizing subsidized energy and to help collect data on fuel usage patterns to combat smuggling. The energy crisis is not just about fixing the untargeted subsidy system but it must also address black market activities and smuggling estimated to siphon off about 20 percent of subsidized petroleum products. Overall, the Morsi government planned to reduce energy subsidies to EGP 99 billion in 2013-14. Yet, with ongoing government changes, all initiatives and planned reforms have been put on hold indefinitely.
The military’s decision to appoint Hazem el-Beblawi, former finance minister and critic of Egypt’s subsidized system, as an interim prime minister signals that a much-needed subsidy overhaul is inevitable and that perhaps Egypt is inching closer towards securing a pending $4.8 billion loan from the IMF. But as Mr. Beblawi recently pointed out, such drastic measures will require a communication strategy along with a public campaign to convince Egyptians that cancelling subsidies is crucial to salvaging the economy and to reassure skeptics that social safety nets will be introduced to protect those most affected by reform.
With a growing population of over 85 million people and dwindling finances, Egypt must undertake energy sector reform sooner rather than later. While broader reforms are still in the pipeline, it is unknown when or how the interim government will introduce painful reforms.
The interim government, led by liberal economists, understands the urgency of restructuring the energy sector but it remains to be seen how they will approach the issue since popular backlash remains the biggest concern in moving forward with any subsidy reforms. One way this can be done is through targeted cash transfers as previously advised by the IMF. Simultaneously, the Petroleum Ministry will need to address black market smuggling of fuel by working with the government on alleviating inflationary pressures and price hikes on the poor. Ultimately, the rationing of fuel should be done in a gradual way to reassure the public of the government’s intensions to protect social welfare and at the same time to lessen budgetary pressures.
Svetlana Milbert is assistant director of the Atlantic Council’s Rafik Hariri Center for the Middle East.
Image: Taxis in line at gas station in Egypt. (photo: Flickr user vagabondblogger)